This model can turn fall apart very quickly under a very-low-interest-rate or NIRP regime. The returns insurers and pension plans make on their investments no longer adequately fund the promises they have made. It gets even worse with NIRP. Think of the poor insurance companies, monstrously bigger than banks in Europe, that are forced by regulations to invest in long-term government bonds, many of which are now earning negative returns. How in the Wide, Wide World of Sports can you make a positive return when you are forced to invest in negative interest-rate bonds?
Then we come to the banks. What happens when they make negative returns on their cash? We haven’t seen extreme scenarios yet, as far as I can tell, but the banks are definitely getting squeezed. Last week Royal Bank of Scotland warned some corporate customers that it may start charging interest to hold their deposits. Some German banks have already done so.
Knowing this practice is a problem, banks try to offset NIRP by cutting other costs: by automating more tasks, laying off employees, closing branches, etc. This year we’ve heard a lot about banks investing in blockchain ledger technology – the same engine that drives Bitcoin digital currency. The banks aren’t doing this because they love Bitcoin. Their interest is in reducing costs, and blockchain applications promise to help them do it. That technology will lead to more job losses down the road.
Between NIRP and assorted technology and regulatory changes, the banking industry is on its way to becoming a kind of regulated utility. This shift might mean fewer bailouts in the future, but it will certainly mean less risk-taking and speculative lending and investing by banks. To the extent this dynamic makes it harder for worthy businesses to get capital, it will contribute to the generally low-growth economic conditions we’ve seen since the crisis.
I have written several letters about the plight of pension funds worldwide. I am gathering information on the situation with insurance companies, which my initial research shows is even more dire. If you have something I should know, please send it to me.
NIRP Problem #5: Distorting Signals
ECB President Mario Draghi famously pledged to do “whatever it takes” to restore eurozone growth. His attempts to fulfill that promise have led to NIRP and other bizarre policies like the central bank’s massive asset purchases.
Whether the ECB’s various interventions are helping the eurozone economy is not yet clear, but they are certainly having consequences, among them the appearance, if not the reality, of central bank interference and favoritism.
The ECB’s corporate bond-buying program, for instance, was originally going to purchase already existing bonds on the open market. However, it has evolved into a kind of closed market in which a favored group of companies issue bonds customized to the ECB’s specifications.
Last week the Wall Street Journal reported that the ECB had gone a step further, buying bonds directly from two Spanish companies through private placements. In other words, the ECB bypassed public markets completely and simply loaned money to selected companies. They weren’t even going to tell anyone. Someone at the WSJ, God bless their attention to detail, did some data mining and found the two private placements. One was to the Spanish oil company Repsol and the other to Iberdrola, an electric power utility. Morgan Stanley acted as underwriter in both cases. I wish my friends at Morgan Stanley would arrange to give me long-term money that cheaply. Just saying.